Small business, Mike Kinsley, and G.W. Bush

Ordinarily columnist Michael Kinsley uses scrupulously clean logic. Something, however, about George W. Bush periodically makes Kinsley blow a fuse and start spouting non sequiturs and illogic. Case in point, this Slate column about Bush’s infatuation with small business.


In essence, Kinsley argues that Bush is in love with small business, and he (meaning: Bush) unjustifiably uses that segment of the economy to justify suspect tax cuts.



“The myth of small business is one of the more ridiculous bipartisan superstitions that influence government policy. Small businesses, by their nature, come and go. They create more jobs than big businesses and wipe out more jobs, too.”


This is interesting contrarian logic, the sort of thing that ordinarily appeals to me. Is it true though? Well, there is unanimity among studies (not to mention, common sense) in showing that gross job creation is inversely correlated with company size. But is Kinsley right, does the argument fall apart when you consider net job creation? In other words, is small business such a large destroyer of jobs that its prowess at creating jobs becomes dismissable? This is a controversial subject, and while the conclusions are not entirely clear, Kinsley is misstating the evidence.


To be specific, Small Business Administration data shows that small business is far ahead of larger business in net job creation, despite having its rate of gross job desctruction. It is misleading to fixate on the latter without pointing out the former, driven, in large part by the numbers: 94% of U.S. businesses have less than fifty employees.


So Kinsley is wrong in his premise, but let’s politely march on and look at one more of his arguments.


He highlights, for example, a recent Bush speech in Albuquerque, New Mexico, where he is at a company called MCT Industries. It was, Bush said, “the American dream”, a private company that made its founder wealthy.


Kinsley demurs, hecking Bush by saying there “is a logical problem here, isn’t there?” His point: Bush is using dubious logic by claiming that small business tax cuts are necessary when MCT and its founder have delivered the American dream.


While I’m fond of mischievous rhetoric, that is just too much. By that illogic of exceptions, the existence of an outlier would invalidate any broader program. To put it in terms with which Kinsley would be familiar, affirmative action programs must not be necessary. Why? Because Bill Cosby is black and he has been successful.


I like Mike, and generally thinks he writes interesting pieces. But rather than demonstrating Bush’s dubious logic, he has mostly given us a Petri dish laced with some of his own.

Analyst exodus continues

News today that technology analyst Chuck Phillips of Morgan Stanley is moving on. He will take on the newly-created position of “executive vice president in charge of customer-related activities” at Oracle, reporting to founder Larry Ellison.


I have no idea what the title means either, but it is a nice opportunity to go back and re-read the Morgan Stanley documents from the global brokerage settlement. Chuck figures regularly and entertainingly.

The metaphysics of financial scams

It is a kind of metaphysical financial question: What happens if you scam people but no-one is scammed? Paul Tetu, a self-described “aspiring screenplay writer, novelist, and movie producer” tested the question recently. (Don’t you love the “aspiring” part?)


As the SEC complaint says, Mr. Tetu has been running ads in the Wall Street Journal and elsewhere for the past five years. In them he promises “High Yield Transactions”, secret trading programs which could generate annual returns of 70 to 100%. Just in case people were nervous about his bona fides, Mr. Teto assured investors that he had worked “with the State Department and the International Monetary Fund and that he had facilitated previous transactions in excess of $100 million”.


Sadly, as the SEC points out, there were issues:




  1. “Tetu’s purported secret trading programs did not exist, and Tetu did not have the ability to generate the returns he promised; ”
  2. “Tetu never understood the precise nature of these so-called secret trading programs, and never met any of the promoters who told him about the transactions;”
  3. “Tetu never made any attempt to verify the existence of these secret programs, to explore the credibility of the promoters or to substantiate the likelihood of the promised returns;”
  4. “Tetu never had any dealings with anyone at the State Department or the International Monetary Fund; and”
  5. “Tetu never consummated any of the types of transactions that he promoted, much less those in excess of $100 million.”

So, there were some problems with the offer. But you’d think someone would have still taken a flyer on this intrepid financial entrepeneur. But then here is the crusher in the SEC complaint:



“Despite his best efforts, Tetu failed to convince anyone to invest in his scheme.”


In other words, despite Mr. Teto’s half-decade trying to scam millions out of investors, he wasn’t able to obtain any money. None. Nada. What is the world coming to?

Excellent reading on hedge funds and short-selling

Sad to say, but many hedge fund managers are illiterate dolts. They are wealthy, illiterate dolts, so there are compensatory attributes, but they’re still nasty sorts to be stuck with at a party.


That is why it is nice to run into brights folks like short-seller Jim Chanos. He runs a billion-dollar New York-based fund that is totally devoted to short-selling — that is, it invests such that it stands to profit if certain stocks fall.


The preceding is, of course, an exceedingly difficult & dangerous business. Why? Well, consider the following:



  1. Stocks naturally trend upward over time as economies grow. Running contrary to that pressure is like swimming upstream against a very strong current.
  2. There are rules that make short-selling difficult, like the so-called up-tick rule. In essence it means you can’t sell a declining stock until the prior trade was higher than the one before it. The idea is to create “bear raids”, but the effects are very different.
  3. Your maximum gain is “only” 100%, but your maximum loss is unlimited. After all, a stock can fall to zero, but it can ascend to any number.

There are other reason why short-selling is a perilous business, but those will do for a starter. You can see, however, how successful short-sellers are very different breeds of cat: individualistic, contarian, stubborn, and so on. They have to be.


To get a look at that difference in action, have a read of this document. It is Jim Chano’s testimony to a hedge fund hearing in Washington this week. A better explication of the business, you will not find, including a fascination section on how Chanos got involves early on with selling both Worldcom and Enron short. Did I mention it is well-written and interesting too?

More on the “bookie of virtue”: William Bennett

While “bookie of virtue” William Bennett has so far escaped a direct connection between his private video gambling and his publicly virtuous positions, I have scooped the New York Times, the Washington Post, and everyone else in finding it.


It is, as you might expect, tricky and indirect. You wouldn’t expect less from Bennett, given how dearly he would like to keep outsiders from his secret gambling penchant. The path, twisted and dark, leads through young women, derelict cars, abstract mathematics, and yes, scandalous as it may sound, a love diary.


Click here to see the path in graphical form. And then call the New York Times, or CNN  … or something.

The GE alumni anomaly

Interesting piece in the WSJ this morning that got me thinking about the “GE alumni anomaly”. As the WSJ pointed out, recent GE alumni, from Gary Wendt at Conseco, to Robert Nardelli at Home Depot, haven’t been unalloyed successes. Their stocks — and the equities of other GE alumns — have generally underperformed the market.

Just for fun, I went back and looked at a subset of GE “graduates” in a miniature event study. How would you have done if you had bought the company’s stock at close of business on the day the GE savior showed up (ex ante), and then sold the position and went short four days later (ex post)?

Here are the results. While it will won’t be the next January effect, it is food for thought….








































ABS CNCEQ.OB HD GE
ex ante $28.80 $6.13 $40.75 $49.38
ex post 33.40 11.25 47.25 51.00
change 16% 84% 16% 3%
current 21.34 0.02 28.76 28.38
change -36% -100% -39% -44%

Fight the Fed — job offers, that is

Apparently it not that good to be king: No-one wants $313,000 a year to run the New York Fed. While some of this is just chance — there were were only two preferred candidates, apparently, and good people have many things they can do with their time — it is also a problem for the Fed. After all, current chair William J. McDonough, 69, is leaving mid-June.


Let me check my calendar … oh, I’m busy too.

Decimalizing liquidity?

SEC chief William Donaldson is rumbling about taking a closer look at “decimalization”. While most investors see prices being quoted in pennies rather than fractions as a huge win, the industry isn’t so sure, and it tells regular scare-stories about decreased spreads leading to lower liquidity.


Translating from broker-speak into real-person speak, brokers liked fractional price differences because they could buy stock from Joe at $10¼ and sell it to Jane at $10½, making 50 cents on the brain-dead transaction. But in a world of decimals where there was no pre-ordained reason for such large differences (“spreads”) between the two prices (the “bid” and the “ask”) market-making suddenly became much less profitable.


That is, of course, good for you and I. Or is it? The fear about lower liquidity is that smaller spreads will mean fewer brokers will be willing to play at any particular price, given how little money they’re likely to make from the transaction. And if that were to happen, then you and I would suffer, as it would become difficult to complete trades, especially large trades, and/or trades in stocks that didn’t trade much volume.


The hypothesis is easily tested, if you have the data. The most exacting decimalization study I have seen (Chakravarty, Panchapagesan, & Wood (NBER 2002)) shows there is little cause for alarm. Institutions, post-decimalization, saw an average 13 basis point cost improvement, or roughly $224-million per month in savings, with no impact on trade execution.


Stat arbs, daytraders, and some specialists may not like decimalization – and it has transformed the limit order book — but investors, both retail and institutional, have done just fine. The prior system was rigged to force a profit to traders through price restrictions; the current system lets the market find the price that keeps things profitable enough for traders to be willing to play.  Leave decimalization alone, Bill.

Urban legends, cow paths, and switchbacks

Wonderful photos and text here demonstrating the trouble with running sidewalks in different places than where people naturally want to walk: they’ll walk elsewhere and create paths.


While the piece is interesting in itself, it is also a nice way of approaching the whole subject of design and architecture in a roundabout, eyes-averted fashion. After all, many designers operate in the same way, creating products that work the way they would like people to function, not the other way around.


There is an urban legend about this sort of thing. It is attached to various places, but it goes like this: When University X was created they didn’t put in any sidewalks. Instead, they just waited for a year to go by, and then paved all the paths people had created from walking around campus.


It is a nifty story, even if it’s not true. Certainly it didn’t happen at my former employer, the University of British Columbia. There I often used to wonder at the attempts to cordon off and re-seed areas of grass beaten down by those determined to take the most direct route. Why fight the natural flow?


I would, however, attach one caveat: the idea only applies in urban settings. In wilderness, for example, letting people walk where they want to can come at a high cost, as anyone who was hiked up a switchbacked mountain trail can tell you. Wahoos almost invariably cut the corners, creating erosion, that will, almost inevitably, degrade the trail for all concerned.

Latest NatPost column

It is admittedly not a new home movie of Pamela Anderson Lee, but an amateur video is being eagerly emailed around in the brokerage business. In it a Bear Stearns analyst is shown promoting an upcoming initial public offering, and that act briefly caused the IPO to be postponed.

On May 2nd brokerage firm Bear Stearns emailed some large investors a video about an upcoming offering of iPayment’s shares. Bear Stearns analyst James Kissane apparently appears in the video mouthing a few nice things about the company that Bear Stearns was underwriting. And that, some allege, runs contrary to the recent settlement in the brokerage industry that separates equity research from investment banking.

While it was a silly thing for the Bear Stearns analyst to do (and the offering came out on Monday anyway), the IPO should not have been delayed. Here is why:

First, the April 28th brokerage settlement separating equity research from investment banking wasn’t in effect when the video was sent to investors. The settlement, as awry as it is, doesn’t take effect until 60 days after it is entered into court files. And that hasn’t happened yet, so there is no reason to haul Bear Stearns up over Kissane’s inconsequential actions.

Some, of course, might suggest that it is sophistry to say that Bear Stearns can get off merely because it beat the deadlines imposed in the April 28th agreement. Fair enough, but we have to be very careful when we start punishing companies for laws that are not yet on the books. That is a dangerous precedent.

And from a more practical standpoint, the Kissane video was emailed on May 2nd, four days after the brokerage settlement was in place. While electronic communications speed up many things, it is highly unlikely that the video was put together in the intervening period just to thumb a nose at regulators. More likely is that the iPayment video was filmed days or weeks earlier, well before anyone knew precisely when or what shape the brokerage settlement would take.

Second, analysts, like the rest of us, know the list of upcoming IPOs from their own firms. It is far from secret. So for Kissane to make comments about an upcoming Bear Stearns IPO should not be, in itself, a hanging offense.

So if it is okay for Kissane to comment on an upcoming IPO, then let’s consider the words he apparently used.

He said, in opening, that it was his “pleasure” to introduce iPayment’s management. I supposed he could have said he was “mad as hell” to be opening for iPayment, but that would have been silly. So let’s strike “please” as being an opening pleasantry, not exactly the sort of thing that Morgan Stanley analyst Mary Meeker used to say about investment banking clients – but oh wait, she was never accused of anything by New York Attorney General Elliot Spitzer.

Nevertheless, let’s throw “pleasure” out and deal, instead, with the more promotional verbiage that reports say followed later. The analyst said, “I think iPayment represents a great way for investors to play a proven winning strategy in the merchant processing space focused on small businesses, which I just think is a tremendous growth opportunity.”

At face value, the words seem damning: “great way … proven winning strategy … tremendous growth opportunity”. Again, however, let’s put it in context. This is one sentence in a longer video; singled out in this way those thirty-three words are given far more prominence than they deserve. They are platitudes, and as a line in a longer video they are more or less meaningless.

What would critics like Elliot Spitzer have had Kissane say, pre-settlement? Perhaps the analyst should have said, “I think iPayment represents a lousy investment in the proven money-losing merchant-processing market, which is, after all, shrinking faster than my own equity analyst ranks.”

Would that have been better? Or perhaps something utterly innocuous, like, “This company is called iPayment, spelled ‘i’, ‘P’, ‘a’, ‘y’, ‘m’, ‘e’, ‘n’, ‘t’. Thanks – have a nice day everyone. And yes, that is a small ‘i’ at the beginning.”

Admittedly, Bear Stearns and analyst Kissane should have exercised more care – it was dumb to give a flush-with-success Elliott Spitzer any more ammunition. And yes, Bear Stearns hasn’t shown much political savvy, what with this latest incident, plus a prior one where Bear Stearns’ executives downplayed the significance of the brokerage settlement.

But these comments on iPayment were inoffensive and pre-settlement. And most investors, to the extent they watched the video at all, likely ignored Kissane’s brief words.

Nevertheless, politicians and lawmakers are twittering away, telling brokerage firms how to speak, how to act, and when to do either. But investors want none of this rough justice. Instead, they are voting with their money: the delayed iPayment IPO opened on Monday of this week, and it traded up as much 34%. Not bad for “tainted” equity research.